THE STRATEGIC PLANNING PROCESS, PART 1

the first of two articles that focus on applying your knowledge of management and strategy to a scenario situation.
Part 1 considers the complexities of strategic planning and how they can be broken down into three main areas
This first article deals with the strategic planning process. Many of the various texts on the market
comprehensively cover the key processes involved in strategic planning. These often involve comprehensive flow
charts with many subparts. Rather than explain these in detail, let us first distil the process into three main
areas:
Strategic analysis.
Strategic choice.
Strategic implementation.
Strategic analysis
Essentially a business will address the following questions:
Where do we want to go?
What constraints exist on our resources?
What are the key threats from the external environment?
Where do we want to go?
The answer to this question is influenced by many factors. Key influencers are often the owners (for example,
shareholders) who may have a particular expectation for the organisation. However, one also needs to take into
account other stakeholder influences, which could include the government, employees and the general
underlying culture of the organisation. These views are very often consolidated into a corporate vision or mission
statement.
What constraints exist on our resources?
Resources needed would include finance, plant and machinery and human resources. However, to make it easy,
I would recommend that you simply think 6Ms. 6Ms is simply a mnemonic used to save time when thinking
about the various resource constraints. It can be summarised as:
money
machinery
manpower
markets
materials
make-up.
The typical questions, which you would ask against each of these resource constraints, would be as follows:
Money
How much do we have?
What is the current cost of our capital?
Is the company excessively geared or are there any opportunities for raising additional finance?

Machinery
This would refer to machinery in the broadest sense of the word, and typical questions one might ask would
include:
How technically up to date is the machinery?
Is there a danger of obsolescence?
Has it been poorly maintained over the years?
Manpower
How expensive is our workforce?
How efficient are our employees?
Is the business overstaffed?
Is it understaffed?
What is the labour turnover rate?
What is the absence rate?
Are there good structures to allow management succession?
Markets
There is a danger of overlapping with the external environment here, so try to keep to such questions as:
Are the markets declining/growing?
Where are new markets emerging?
How strong are our brands in the current market?
Materials
How expensive are our materials compared to our competitors?
Do our suppliers have excessive control of materials?
Do we have favourable access to materials?
Are our raw materials becoming exhausted?
Make-up
What type of structures do we have and are they likely to limit future growth?
What is the culture of the organisation and will it stifle or fuel future developments?
We will explain later how we can apply these concepts to a case scenario.
What are the key threats from the external environment?
Once we have established constraints on our internal resources we need to assess the threat posed by the
external environment. The easiest way to assess the external environment is to use the following two
frameworks:

Porters five forces.

PESTEL analysis.
Porters five forces
The American management writer Michael Porter describes the main external competitive threats to be
summarised by his five forces model. Essentially, this model determines the level of competition an organisation
is facing by assessing the extent to which the five forces are relevant. The five forces are summarised as follows:
The threat from new entrants.
The bargaining power of buyers.
The bargaining power of suppliers.
The threat from substitute products.
The extent of competitive rivalry.
1. The threat from new entrants
This is a problem because if competitors can easily enter your business sector they will be able to put a ceiling on
your profits. Therefore, the greater the threat from new entrants entering the sector, the higher the levels of
competition. The ease which new entrants can enter the business segment is largely determined by the extent
of the barriers to entry. You potentially could get a whole Section B question, which goes into detail on barriers
to entry.
The following summarises the main barriers to entry.
Capital cost of entry. The higher the capital cost, the greater the deterrent to someone entering the business
and, therefore, the likelihood of competition being less than in industries where it is much cheaper to set up
business.
Economies of scale. This will apply if a substantial investment is needed to allow a new entrant to achieve cost
parity. Therefore, anyone entering the segment that cannot match the economies of scale will be at a substantial
cost disadvantage from the start.
Differentiation. Differentiation is said to occur if consumers perceive a product or service to have properties,
which make it unique or distinct from its rivals. The differentiation can be in the appearance of the product, its
brand name or services attached to the product for example, Concorde. Therefore, if new entrants are to be
successful in entering the market they will need to spend a lot of money on developing the image of the product
hence, they are likely to be put off.
Switching costs. This is the cost not incurred by a new company wishing to enter the market but by the existing
customers. If the buyer will incur expense by changing to a new supplier, they may not wish to change. For
example, when the compact disc was invented consumers had to incur a cost of a CD player, as the new compact
discs would not work on a conventional record player.
Expected retaliation. If a competitor entering a market believes that the reaction of an existing firm will be too
great then they will not enter the market.
Legislation. There might be patent protection for a product or the government might only license certain
companies to operate in certain segments
for example, Nuclear Power.
Access to distribution channels. Existing relationships between manufacturers and the key distributors of the
products may make it difficult for anyone else to enter the market.

Therefore, in summary, when thinking about the barriers to entry go through the above list in your planning to
see which of them apply. Remember that it is unlikely that they all will apply, but the checklist should ensure
that all those that do apply would be picked up.
2. The bargaining power of buyers
Do the buyers of the product have the power to depress the suppliers prices? If the answer to this question is
yes, it is likely that competition will increase. Buyers will have power when:
they are concentrated and can exert pressure on the supplier
the buyer has a choice of alternative sources of supply.
3. The bargaining power of suppliers
The extent of supplier bargaining power is very closely linked in with the issues of buyer power. The extent of the
power of the suppliers will be affected by:
the concentration of suppliers: if only a few suppliers, the buyers will have less opportunity to shop around
the degree to which products can be substituted by the various suppliers
the level of importance attached to the buyer by the supplier. The switching costs of moving to another supplier.
4. The threat from substitute products
If there are similar products that can be used as substitute then the demand for the product will increase or
decrease as it moves upwards or downwards in price relative to substitutes.
5. The extent of competitive rivalry
The most competitive markets will be affected by the previously discussed forces. However they will also be
affected by:
the number of competitors and the degree of concentration
the rate of growth of the industry
the cost structures if high fixed costs prices are often cut to generate volume
the exit costs. If they are high, firms may be willing to accept low margins so as to stay in the industry.
PESTEL factors
The other framework, which should be applied when surveying the external environment, is PESTEL factors:
Political
Economic
Social
Technological
Environmental
Legal.
Again, all of these factors will not necessarily apply but provide a useful checklist against which you can compare
in an exam situation. They are explained more fully below.

Political environment
The organisation must react to the attitude of the political party that is in power at the time. The government is
the nations largest supplier, employer, customer and investor and any change in government spending priorities
can have a significant impact on a business for example, the defence industry.
Political influence will include legislation on trading, pricing, dividends, tax, employment, as well as health and
safety.
Economic environment
The current state of the economy can affect how a company performs. The rate of growth in the economy is a
measure of the overall change in demand for goods and services. Other economic influences include the
following:
Taxation levels.
Inflation rate.
The balance of trade and exchange rates.
The level of unemployment.
Interest rates and availability of credit.
Government subsidies.
One should also look at international economic issues, which could include the following:
The extent of protectionist measures.
Comparative rates of growth, inflation, wages and taxation.
The freedom of capital movement.
Economic agreements.
Relative exchange rates.
The social environment
The organisation is also influenced by changes in the nature, habits and attitudes of society.
Changing values and lifestyles.
Changing values and beliefs.
Changing patterns of work and leisure.
Demographic changes.
Changing mix in the ethnic and religious background of the population.
The technological influences
This is an area in which change takes place very rapidly and the organisations need to be constantly aware of
what is going on. Technological change can influence the following:
Changes in production techniques.
The type of products that are made and sold.
How services are provided.

How we identify markets.

Environmental
This concerns issues regarding factors that could impact on the ecological balance of the environment and could
include such issues as climate change and pollution
Legal environment
How an organisation does business:
Law of contract, law on unfair selling practices, health and safety legislation.
How an organisation treats its employees, employment laws.
How an organisation gives information about its performance.
Legislation on competitive behaviour.
Environmental legislation.
Therefore, when surveying the external environment think through Porters five forces and PESTEL factors and
you will have a fully comprehensive framework with which you can assess the case.
Past exam-related example
Championsoft is a specialist software house, which has developed and now markets a modular suite of financial
software packages under the product name of Champlan. In addition, the company provides a systems design
consultancy service to the financial services industry. The company was established in 1988 and the three
founding shareholders are also the three full-time working directors. Extracts from the financial results for the
last three years are given below. These show declining profitability although aggregate sales revenue has
increased year on year.

Year

Champlan
units sold

Champlan
sales

Systems
design
services
sales

Operating
profits

2010

2,050

922,500

650,000

162,000

2011

2,700

1,080,000

600,000

144,000

2012

3,600

1,260,000

550,000

107,500

Operating profit is before interest charges and taxation. The current interest rate on the medium term loan is
10% per annum.

Year

Fixed
assets

Current
assets

Current
liabilities

Medium
term loan

Share
capital
and
reserves

2010

950,000

425,000

260,000

200,000

915,000

2011

1,000,000

525,000

375,000

200,000

950,000

2012

1,225,000

650,000

475,000

400,000

1,000,000

The current liabilities figure includes an overdraft with the bank of 300,000. This is also the agreed maximum.
The company owns its own premises and these comprise the majority of fixed assets. The premises have
recently been expanded to cope with the increased sales volume of the Champlan package. Although the
consultancy workload of the company has shown some decline in recent years, this has been due to pressure on
the software staff to develop more powerful versions of the Champlan package rather than a shortage of
potential work. Championsoft is well regarded in the system design services field and attracts good profit
margins on the work carried out. It is estimated that the operating profit to sales ratio on system design services
is in the region of 15%.
Championsoft employs 18 people mainly as software specialists. There is little subcontract software
development undertaken. The managing director and majority shareholder with 40% of the voting capital is
Simon Champion. He was the prime mover behind the creation of Championsoft and has substantial experience
in the financial services industry. He sees his main role as ensuring the efficient day-to-day administration of the
business. The software technical aspects of the business are managed by the technical director, Dr John Chan,
who holds 30% of the voting share capital. He is responsible for research and development on the Champlan
product range, customer technical support on software products and systems design consultancy projects.
Jill Mortimer, the third director, holds the final 30% of voting shares and is in charge of sales and marketing of
both software products and consultancy services. Her background is in the marketing of fast moving consumer
products.
Championsoft see its Champlan product range as a market leader in terms of quality and functionality, although
this segment of the software market appears to be increasingly driven by price and product awareness. There is
also a recent marked tendency for hardware suppliers to bundle in the Champlan product as part of the
hardware price of their product. The main competitor to Champlan is the Pennsoft product range. Pennsoft is
part of a large international organisation, and its product range is very similar to Champlan if lacking in its level of
functionality. Pennsoft software is marketed at prices, which have always undercut Champlan. Jill Mortimer
believes that Pennsoft hold about two-thirds of the market, Champlan about one-quarter and the rest is split
among a few other software houses. There are few barriers to other software houses entering this market.
Almost any quality software house is able to produce a similar product for this market providing that they are
willing to devote sufficient resources.
Jill Mortimer has a strong personality and her views have tended to dominate the recent direction of the
business. She believes that Championsoft must cut its prices and put more effort into winning sales. Look at the
way the software market is developing. Every year there is a bigger market as new users get access to the
hardware. Our extra sales effort and a bigger sales force will easily be covered by additional unit sales. We must
tackle Pennsoft head on and capture some of their market share. Last year Championsoft spent 100,000 on
advertising while Pennsoft spent in the region of 500,000.

Simon Champion is not fully convinced. Although our current advertising has generated lots of enquiries, very
few of these resulted in firm sales. In fact, the high level of spending on promotion is straining our cash flow. He
was thinking about the letter recently received from the bank which, while professing continuing support,
pointed out that Championsofts overdraft was rising year on year and that this must not be seen as a
permanent source of finance. The bank had concluded that it would like to see some medium-term projection
about how the overdraft was to be brought under control.
As usual John Chan took the opportunity to launch into his familiar attack on the marketing strategy or lack of
strategy as he was heard to remark to his software team: We should move away from the package market and
into consultancy activities. These build on our reputation and software expertise.
The margins are good and we can sell on recommendation not expensive advertising campaigns. As it stands,
my team is being torn between development of Champlan and working on software projects. We cannot do both
well, we are in danger of losing clients and at the same time failing to keep the edge over Pennsoft.
Simon Champion was at a loss how to respond. Something had to be done, but what?
Simon Champion has come to see you, as the companys auditor, and has asked for your objective advice. He
feels that Championsoft needs a strategy but is not sure what it should be or how to go about preparing it.
Events move so fast in our industry that plans are out of date before they can be implemented was a comment
made at your meeting.
Requirements
(a) Identify any additional internal and external information, which you need before you could set about writing
your report and indicate how you would gather such information. (12 marks)
Suggested approach
As you can see, the question asked above in the case scenario clearly seeks for information of both an internal
and external nature together with how you would gather such information.
All answers in the exam should be roughly planned out and all you need to remember to score well in this part of
the question are the mnemonics to help you break down the internal and external factors.
So, to help get some structure for internal factors, think 6Ms and you think:
Money
Markets
Machinery
Materials
Manpower
Make-up
We then need to quickly think which of these 6Ms would be most relevant to the answer. I would expect your
thought process to go something like the following:
Machinery? Is machinery relevant to Championsofts business as a specialist software house? How cost effective
is the current use of the machinery? You may comment on the fact that in order to remain competitive ongoing
investment in the latest equipment is likely to be relevant.
Money? An analysis of profitability of individual products, how competitive is the interest on the medium-term
loan?
Manpower? Cost/productivity/staff turnover of the current employees compared to the industry average.
Markets? The growth potential for financial software and the systems design consultancy market.

Materials? In the case of Championsoft, materials do not seem to be so relevant so I would suggest no comment
is needed.
Makeup? We would need to look at the current culture of the staff and assess whether it would be happy if one
side of the business was run down for example, software development.
Therefore, we have shown how, by using the 6Ms approach in our plan, we can provide ourselves with more
than enough criteria on which to comment. We should now be confident in applying five forces and PESTEL in
much the same way for example, questions regarding the five forces would include:
What are the main barriers to entry for new entrants entering the software and design consultancy business and
how much of a deterrent are they?
Do buyers have the power to ask Championsoft to reduce its prices? You may comment on the fact that it has an
alternative choice in Pennsoft and therefore may be able to get a more competitive price than if Pennsoft was
not there.
Are there any other packages out in the market that could be used as a substitute for Championsofts products?
Questions of a PESTEL nature would be similar to those used above.
Armed with this information in your plan you should now be able to develop an answer that should fulfil the 12
marks allocated. Do not forget to answer the entire question, which required suggestions as to how you would
gather such information suggested. It must be stressed that all of the 6Ms, five forces and PESTEL need not
necessarily be used in your answer, but they should almost certainly be used in developing your answer plan.
Past exam-related example
Bowland Carpets Ltd
An example of a question that concentrates on a specific part of the above environmental analysis is given
below.
Bowland Carpets Ltd is a major producer of carpets within the UK. The company was taken over by its present
parent company, Universal Carpet Inc, in 2012. Universal Carpet is a giant, vertically integrated carpet
manufacturing and retailing business, based within the US but with interests all over the world.
Bowland Carpets operates within the UK in various market segments, including the high value contract and
industrial carpeting area hotels and office blocks, etc and in the domestic (household) market. Within the
latter the choice is reasonably wide, ranging from luxury carpets down to the cheaper products. Industrial and
contract carpets contribute 25% of Bowland Carpets total annual turnover, which is currently 80m. During the
late 1980s the turnover of the company was growing at 8% per annum, but since 2011 sales have dropped by 5%
per annum in real terms. Bowland Carpets has traditionally been known as a producer of high quality carpets,
but at competitive prices. It has a powerful brand name, and it has been able to protect this by producing the
cheaper, lower quality products under a secondary brand name. It has also maintained a good relationship with
the many carpet distributors throughout the UK, particularly the mainstream retail organisations.
The recent decline in carpet sales, partly recession-induced, has worried the US parent company. It has
recognised that the increasing concentration within the European carpet-manufacturing sector has led to
aggressive competition within a low growth industry. It does not believe that overseas sales growth by Bowland
Carpets is an attractive proposition, as this would compete with other Universal Carpet companies. It does,
however, consider that vertical integration into retailing (as already practised within the US) is a serious option.
This would give the UK company increased control over its sales and reduce its exposure to competition. The
president of the parent company has asked Jeremy Smiles, managing director of Bowland Carpets, to address
this issue and provide guidance to the US board of directors. Funding does not appear to be a major issue at this
time as the parent company has large cash reserves on its balance sheet.

Requirements
Acting in the capacity of Jeremy Smiles you are required to outline the various issues, which might be of
significance for the management of the parent company. Your answer should cover the following:
(a) To what extent do the distinctive competencies of Bowland Carpets conform with the key success factors
required for the proposed strategy change? (10 marks)
(b) Suggest and discuss what might be the prime entry barriers prevalent in the carpet retailing sector. (7 marks)
(c) In an external environmental analysis concerning the proposed strategy shift, what are likely to be the key
external influences that could impact upon the Bowland Carpets decision? (8 marks)
(Total: 25 marks)
Suggested approach
If we are to concentrate on Part (b), you can see that it asks for the prime entry barriers in the carpet retailing
sector. All that you need to do here is undertake a quick brainstorm of what we described earlier as barriers to
entry and then see whether any of them will apply to the carpet retailing sector.
So thinking back the main barriers to entry which we listed were:
Capital cost of entry
Economies of scale
Differentiation
Switching costs
Expected retaliation
Legislation
Access to distribution channels
Most of the above could be a potential barrier in the carpet retailing sector, but in order to score high marks you
need to apply them in the context of carpet retailing rather than just list them.
Capital cost of entry. How much investment would be required in a lease and stock?
Economies of scale. Are there any current carpet retailers that have superior buying power and economies of
scale in distribution and marketing?
Differentiation. Are there any retailers that have high levels of customer loyalty to their shop, which would
prevent them from buying carpets from anyone else?
Switching costs. Switching costs are not relevant and one would become relevant if a householder were to enter
into a lifelong contractual agreement to buy all their carpets from one particular retailer, which is clearly
unlikely.
Expected retaliation. If a retailer existed in the carpet retailing sector that was very aggressive to any potential
new competitor this could prove to be a potential barrier.
Legislation. Are there any planning constraints or specific licences that are needed to operate in the carpet
retailing sector.
Access to distribution channels. How easy will it be for a new entrant in the carpet retailing sector to find a prime
retailing site that is appropriate for the sale of carpets.
Therefore, using the framework in an applied way, we have been able to construct an answer that, if presented
appropriately, will be worth almost maximum marks. If you look at Part (c) you will see that the external analysis
frameworks fit in perfectly again see if you can do it.

Summary
Hopefully now when we think about the strategic planning process we think about:
Strategic Analysis.
Strategic Choice.
Strategic Implementation. This article has explained in detail the process of strategic analysis, which we should
all be able to break down into:
- Where do we want to go?
- What constraints exist on our resources? (6Ms)
- What are the key threats from the external environment? (five forces, PESTEL)
The next article will take a similar approach to the issues of strategic choice and implementation.
Sean Purcell BA ACMA is a leading freelance lecturer for Paper P3 and lectures on the ACCA Study School and Train
the Trainer Programme for Paper P3
Last updated: 28 Jul 2016

THE STRATEGIC PLANNING PROCESS, PART 2

The second of two articles that focus on applying your knowledge of management and strategy to a scenario
situation. Part 1 considered the complexities of strategic planning and how they can be broken down into three
main areas. Part 2 adopts a similar simplification approach to the issues of strategic choice and strategic
implementation
One of the main problems faced by students on Paper P3 is application of knowledge. Early on in their
preparation most students feel comfortable with all that is discussed in Paper P3 and many develop a false sense
of security preferring to concentrate on what seems to be an overwhelming amount of information for Papers
P2, P4 or P6. It is only when students enter the revision phase do they realise that you need to do much more
than just learn the notes in order to pass the exam. The main skill that a student needs to develop is an ability to
apply the acquired knowledge in a scenario situation. The following provides an insight into how to apply your
knowledge effectively.
In the previous article we established how the complexities of strategic planning could be broken down into
three main areas:
Strategic analysis
Strategic choice
Strategic implementation
The previous article comprehensively explained strategic analysis by breaking it down into three questions:
Where do we want to go? (Think stakeholder constraints)
What constraints exist on our resources? (Think 6Ms)
What are the key threats from the external environment? (Think PESTEL and five forces)
In this article we are going to try to adopt a similar simplification approach to the issues of strategic choice and
strategic implementation.

Strategic choice
Johnson and Scholes break down the issue of strategic choice into three distinct subheadings, which are:
On what basis do we decide to compete?
Which direction should we choose?
How are we going to achieve the chosen direction?
On what basis do we decide to compete?
A useful framework to use here is Porters generic strategies. Michael Porter stated that a firm that is wishing to
obtain competitive advantage over its rivals is faced with two choices:
Choice 1: Is the company seeking to compete by achieving lower costs than its rivals achieve and by charging
similar prices for the products and services that it offers, thereby achieving advantage via superior profitability?
Or
Is the company wishing to differentiate itself and the customer is prepared to pay a premium price for the added
value which the customer perceives in the product, and thereby enjoys greater margin than the undifferentiated
product.
Choice 2: What is the scope of the area in which the company wishes to obtain competitive advantage? Is it
industry-wide or is it restricted to a specific niche?
The answers to these two choices leave the organisation faced with three generic strategies, which are defined
as:
cost leadership
differentiation
focus.
1. Cost leadership
Set out to be the lowest cost producer in an industry. By producing at the lowest possible cost the manufacturer
can compete on price with every other producer in the industry and earn the highest unit profits.
In order to achieve cost leadership some of the following need to be in place:
Seek to set up production facilities for mass production as these will facilitate the economies of scale advantages
to be achieved.
Invest in the latest technology improved quality less labour needed.
Seek to obtain favourable access to sources of raw materials.
Look to develop product designs that facilitate automation.
Minimise overhead costs by exploiting bargaining power.
Concentrate on productivity objectives and constantly seek to improve efficiency and economy for example,
ZBB, value chain analysis.
One should also be aware of the drawbacks of such a strategy, such as the need to continually keep up to date
with potential changes in technology or consumer tastes.

2. Differentiation
A firm differentiates itself from its competitors when it provides something unique that is valuable to buyers.
Differentiation occurs when the differentiated product is able to obtain a price premium in the market that is
above the cost incurred to create the differentiation.
As a consequence of differentiation being about uniqueness, it is not really possible to give an exhaustive list
detailing how a firm may differentiate itself. To truly differentiate yourself we must understand the product or
service offered and the customer to whom you are selling it.
Ways of achieving differentiation
Image differentiation
Marketing is used to feign differentiation where it otherwise does not exist ie an image is created for the
product. This can also include cosmetic differences to a product that does not enhance its performance in any
serious way for example, perfume colour, size, packaging.
Support differentiation
More substantial, but still has no effect on the product itself, is to differentiate on the basis of something that
goes alongside the product, some basis of support.
This may have to do with selling for example, 0% finance, 24-hour delivery.
Quality differentiation
This means the features of the product that make it better not fundamentally different, but just better. The
product will perform with:
greater initial reliability
greater long-term durability
superior performance.
Design differentiation
Differentiate on the basis of design and offer the customer something that is truly different as it breaks away
from the dominant design if there is one for example, Apples iMac computer.
Reward of a differentiation strategy
Consumers are likely to pay a higher price for the goods because of the added value created by the
differentiation.
3. Focus
A focus strategy is based on fragmenting the market and focusing on particular market niche. The firm will not
market its products industry-wide but will concentrate on a particular type of buyer or geographical area.
Cost focus: This involves selecting a particular niche in the market and focusing on providing products for that
niche. By concentrating on a limited range of products or a small geographical area, the costs can be kept low.
Differentiation focus: Select a particular niche and concentrate on competing in that niche on the basis of
differentiation for example, luxury goods.
This can be summarised in the following diagram:

We stated that the alternative directions available to a business could be described in general terms as follows:
Do nothing
Withdrawal
Market penetration
Product development
Market development
Diversification
Do nothing
This involves following the current strategy while events around change and can often prove to be a successful
short-term strategy. Basically, if an organisation is exposed to some form of competitive threat, its short-term
objective is to not react and, hence, get involved in what could be an expensive decision.
Sell out/withdraw from the market
This may be followed so as to maximise the return on a business that may be at the top of its cycle and, hence,
will be in line with the goal of maximisation of cash flows. Withdrawal from a business sector may be chosen to
give the business more focus for example, Richard Bransons decision to sell his original business Virgin
Records to concentrate on the airlines business.
Market penetration
This involves increasing the market share in the current market with the current product. Market share can be
enhanced by such techniques as improved quality, productivity or increased marketing activity.
Product development
This involves introducing a new product into the current market. The product change is often the result of
changes and modifications to an existing successful product for example, Mars ice cream. This is an alternative
to the present product and builds on present knowledge and skills.
Market development
In this case the organisation keeps its tried and tested products but aims to apply them to different market
segments. This strategy maintains the security of the present product while enabling extra revenue to be
generated from new segments for example, McDonalds and its geographic market development.

Diversification
This is the most risky of the product market strategies as it involves the introduction of a totally new product in a
new market. Diversification can either be related or unrelated.
Related diversification
This involves development of the product and market but still remaining within the broad confines of the
industry. There are three main types.
Backward. A development into the business that inputs into the present business for example, move up the
supply chain into raw material inputs.
Forward. A development into activities concerned with a companys outputs also called downstream integration
for example, move down the supply chain into distribution activities.
Horizontal. Movement into activities that are competitive with existing activities for example, to benefit access
to market or technology.
Unrelated diversification
This involves movement into industries that bear little relationship to the present one and is often the result of a
profit motive.
Ansoff represented the last four choices in his product/market matrix.

Ansoff's product market matrix

How?
The final problem that must be overcome is to decide how the chosen strategic option should be undertaken.
The options available are:
internal development
external development/acquisition
joint development.

Internal development
Reasons
Often undertaken to maintain the present equilibrium within the company as it is much less disruptive than an
acquisition. Another reason may be that there is not sufficient finance available for an acquisition or that the
government may prevent acquisition/merger through legislation.
Acquisitions
If there is sufficient finance available an acquisition will provide a very quick way of providing access to new
product/market areas and the new organisation will have economies of scale advantages.
Joint development
A formal agreement between two or more organisations to undertake a new venture together for example,
Airbus (spreading of cost).
Methods of joint development
Consortia. Two or more firms working together to share the costs and benefits of a business opportunity.
Joint venture. A separate business entity whose shares are owned by two or more business entities.
Strategic alliance. A long-term agreement to share knowledge, technology or business opportunities.
Franchising. The purchase of the right to exploit a business brand in return for a capital sum and a share of
profits or turnover. The franchiser also usually provides marketing and technical support to the purchaser of the
franchise.
Licensing. The right to exploit an invention or resource in return for a share of proceeds. Differs from franchise
because there will be little central support.
To summarise, we can use Figure 1. Once all the alternative options have been generated we need to evaluate
their appropriateness before making a choice. A useful framework to apply when considering the
appropriateness of an option is:
suitability
feasibility
acceptability
Suitability
Suitability identifies the extent to which the proposed strategy enhances the situation identified in the strategic
analysis. The following questions need to be addressed about the strategic options:
Does it close the planning gap?
Does it address threats and weaknesses?
Does it build on identified strengths and exploit opportunities?
Does it fit in with the organisations mission?
Will the portfolio remain balanced?
Feasibility
The issue of feasibility evaluates whether the chosen strategy can be implemented successfully. The resources
the organisation has at its disposal will obviously determine this. To save time, simply think about the 6Ms.

Acceptability
The final issue to address is whether the selected strategy will meet the expectations of the key stakeholders in
the firm and typical issues to be looked at would include the level of risk and return resulting from the option.
Remember that in the exam it is unlikely that you are going to get a question that asks you to regurgitate the
information on strategic choice in the way in which I have just explained to you. Questions will normally touch
on some part of the process we have described and if you have an in-depth understanding of everything that we
have covered you will be able to construct much more comprehensive arguments in the exam. We will show this
in a previous exam question later.
Strategic implementation
The area of strategic implementation covers many areas from project management to structure. However, as
with strategic analysis and strategic choice, it is possible to simplify the issues in to a number of key subheadings:
Resource management.
Organisational structure.
Management of change.
Resource management
This will ensure that the 6Ms are working for you in the best way possible. Budgets and other performance
management tools are likely to be used here.
Organisational structure
This will deal with issues regarding the levels of centralisation and decentralisation, together with structural form
and style of management.
Management of change
The scope, speed and style of the changes need to be carefully reviewed in order to obtain full commitment to
them. A useful model of change to remember is Kurt Lewins three-step model, which involved:
unfreeze
change
refreeze.
Unfreeze
For the change to take place the existing equilibrium must be broken down before a new one can be adopted.
Change
This is the second stage, mainly concerned with identifying what the new, desirable behaviour or norm should
be, communicating it and encouraging individuals and groups to own the new attitude or behaviour. To be
successful, one should consider the adoption of the following management styles to improve the acceptance of
the change:
Participation with employees affected by the change, so that they feel more of a sense of ownership.
Education and communication of the new ways, so that they fully understand what is going on and are not in a
situation where they are afraid of the unknown and therefore show resistance.
Negotiation may also be appropriate if there are large group stakeholders such as a trade union.

Refreeze
This is the final stage, implying consolidation or reinforcement of the new behaviour. Positive reinforcement
(praise, reward, etc) or negative reinforcement (sanctions applied to those who deviate from the new behaviour)
may be used. You should also look at the Change Kaleidoscope and Cultural Web
Therefore to summarise what we have just said:
Strategic choice
On what basis do we decide to compete? (Porters generic strategies.)
Which direction should we choose? (Ansoffs product market matrix, do nothing, withdraw.)
How are we going to achieve the chosen direction? (Internal external joint venture.)
Strategic implementation
Resource management (6Ms)
Organisational structure (centralisation, decentralisation, specific structural form)
Management of change (unfreeze, change, refreeze)
Let us see how we can expect to get questioned in this area in the exam.
Question 1
Sample ACCA exam
Jerome Gulsand is the owner and chief executive of a chain of 20 sports equipment shops, Sportak. These shops
are clustered in the south of the country. The company is privately owned by the family and the freeholds of
these shops, which the company owns and which are on prime retail sites, account for the majority of the assets
of Sportak. The company sells a wide range of sports equipment such as golf clubs, tennis, skiing equipment,
soccer and other sports equipment. Recently it has expanded its range to include certain types of designer
sports clothing.
The company was founded by Jeromes father a quarter of a century earlier when he opened his first small shop.
Over the next 25 years the company grew steadily. A major reason for this successful development lay with the
philosophy of Jeromes father who delegated much of the decision-making to the individual shop managers. He
believed that this gave the local managers a higher degree of motivation. It also allowed them to respond to
local demand conditions as stock ordering was carried out by each shop and was not organised at the head
office. The managers were also permitted to develop local marketing activities, using sales promotions and
publicity as they felt appropriate.
These shop managers were remunerated partly by a basic salary and partly by a sales-related performance
bonus, which could be up to 40% of their basic salary. These methods of operation were satisfactory while the
company was operating in a steady growth environment. However, by late 2007 there was evidence that
Sportaks overall position within the market was weakening. Sales had stabilised but, even more importantly,
competition was growing from a number of discount traders who were prepared to operate on low profit
margins but with larger volumes. It was at this time that Jerome took over the company from his father.
Jerome was impatient with the lack of growth. By nature he was an entrepreneur who sought growth. He was
not sure that the steady organic growth was appropriate to these conditions. His fathers policy had been to
open a store each year, funding this growth out of current earnings. Jerome saw that the market was becoming
so competitive that even small and specialist markets were proving to be vulnerable. He believed that only the
big, nationwide retail chains would survive and that the smaller sized groups would be taken over by the larger
chains of sports goods retailers who were more profitable and had greater capability to raise finance.
He decided that a dash for growth was required if the company was to achieve the critical size to survive in the
market place. It had been suggested to him that the franchising of the Sportak brand name would be a
reasonable and relatively risk-free method of expansion. Growth, using other peoples money, has its
advantages, but it did not appeal to Jerome. He wanted a more hands-on approach.
At about this time another chain of 15 sports shops became available for purchase. This group was in a distinctly
separate area of the country about 150 miles from Sportaks current area of operations. As the overall sports

equipment and sportswear market was still growing, the price being asked for this acquisition was rather high.
However, Jerome was convinced that this was too good an opportunity to miss. He believed that Sportak needed
this expansion so as to take advantage of the profitable sales still available in this sector. However, for an
acquisition of this size, it was obvious that the growth could not be funded internally. Jerome assumed that he
might use the freeholds of the properties Sportak owned as securities for the finance the company needed to
borrow. Before approaching the bank Jerome discussed this issue with his accountant and offered the following
ideas for his proposed expansion.
In anticipating this proposed expansion and the need to manage an enlarged group, Jerome believes that it is
time for a strong and centralising leader. Recognising that the current system of product ordering is delegated to
individual store managers, he proposes to provide a centralised purchasing function based upon a warehouse
owned and controlled by Sportak. Individual shop managers will be permitted to decide upon their stock range,
but they will have to order from the central warehouse set up by Sportak.
Jerome has also decided to tackle the problem of marketing and, in particular, promotion. The decentralised
approach adopted by his father has not brought about the development of a well-known image and, therefore,
the brand of Sportak needs to be strengthened. Under Jeromes plan it is proposed to allocate a substantial
budget 15% of sales to spend on press advertising and on public relations, and this level of commitment will
continue for the foreseeable future. Sports personalities will be paid to appear in all stores, which will have to be
re-equipped. By a competent use of merchandising it is hoped that these stores will increasingly be recognised
as centres for influencing the fashion of both sports equipment and clothing. The shop managers will also be
encouraged to stock more expensive lines of products where the margins will be higher and, in addition, they
will be expected to hold much more stock. A criticism of the stores when Jeromes father was in charge was that
they were often short of stock. Most customers were unwilling to wait for the product to be ordered and they
therefore bought from competitors shops.
Jerome recognised that during this period of change Sportak might lose a number of its key shop managers.
These people have enjoyed substantial autonomy, and although they will still have some freedom on the stock
range that they offer, they might increasingly see their freedom to act as managers being eroded. In
appreciating that these shop managers provide much goodwill and their loss would be damaging to the
company, Jerome is proposing to increase their sales-related bonuses as an inducement to stay.
Jerome fully understands that the costs incurred in the proposed acquisition involve more than the purchase of
the new shops. Store modernisation programmes for all the shops, as well as upgrading stock with a wider and
more sophisticated range of products, will also require funding. Forecasts of immediate future sales appear to
be attractive. Jerome anticipates that sales per store will rise by about 8% over the next year. He believes that
this growth in sales, accompanied by his more aggressive approach to retailing, will enable his bold expansion
plans for Sportak to be achieved. Above all, Jerome wishes to see his company, Sportak, become a national
company, no longer having to operate as a regional retailer does.
In Table 1 is a summary of the figures that have been prepared by Jeromes accountant for discussion. Part of
the data has been obtained from trade association statistics as well as government forecasts.
Requirements
(a) Jerome Gulsands father was a great believer in the decentralisation of both operations and decision making.
To what extent has this process harmed or benefited Sportak? Provide examples to justify your arguments. (10
marks)
(b) Evaluate the key features that you consider to be important and would expect to see in the business plan
that Jerome Gulsand would have to present to his bank to support his application for financial assistance. (15
marks)
(c) Acting in the position of Jerome Gulsands accountant, and using the financial data provided and the
intentions developed by Jerome, assess the viability of the strategy that has been proposed by him. (15 marks)
(d) Discuss whether a franchise operation would have been a better option for expansion than an acquisition.
(10 marks)

Table 1
2007
Actual
m

2008
Budget
m

2009
Forecast
m

2010
Forecast
m

Sales of revenue

30.00

29.50

58.80

57.96

Costs of sales

15.00

14.75

25.28

24.92

Gross margin

15.00

14.75

33.52

33.04

Expenses

12.00

12.50

29.50

29.75

Operating profit

3.00

2.25

4.02

3.29

Interest paid

0.00

0.00

2.50

2.50

Proft after interest

3.00

2.25

1.52

0.79

Fixed assets

15.00

15.00

34.00

34.00

Current assets

6.00

5.90

9.80

9.66

Current liabilities

3.75

3.69

7.35

7.25

Equity

24.75

24.59

26.15

25.91

Debt

0.00

0.00

25.00

25.00

Gross margin

50%

50%

57%

57%

Return of sales

10%

7.62%

6.83%

5.67%

Activity ratio

1.21

1.20

1.15

1.14

Return on net assets

12.2

9.15

7.85

6.46

2007
Actual
m

2008
Budget
m

2009
Forecast
m

2010
Forecast
m

ROE

12.2

9.15

5.80

3.04

Industry sales
(2000 100)

125

135

140

138

Part (a) examines your knowledge of the implementation stage by asking a specific question on structure and
whether you believe decentralisation has had any detrimental effect on Sportak. If you were to brainstorm the
main issues regarding centralisation and decentralization, and then see which apply in the context of the case, a
comprehensive answer would be able to be obtained.
Part (b) would be best answered by mixing common sense with the key issues from strategic analysis, strategic
choice and strategic implementation. Common sense would tell you that the business plan should include an
overview of Sportaks business. More detailed information should be provided on the organisations resources
(6Ms), together with an overview of the business environment in which it exists (use PESTEL and five forces for
inspiration). A clear description of the basis on which Sportak intended to compete should also be included (use
Porters generic strategies and Ansoffs product market matrix for inspiration) together with the likely returns
the business is to make from the chosen strategy.
Part (c) requires you to apply the financial skills you have learned throughout your ACCA studies to give an
overview of how viable Jeromes plans are.
Part (d) again would have been easily answered if you had approached your studies in the logical way suggested
earlier and it specifically dealt with the how? Part of the strategic choice stage. (Use the internal, external or
joint venture model for inspiration).
Summary
Hopefully you are now able to overview the strategic planning part of the syllabus in a more systematic and
logical way. All you need to remember is the key steps of strategic analysis, choice and implementation. This
should then set off another chain of words in your head, such as:
strategic analysis (think 6Ms, think PESTEL and five forces and stakeholder constraints.)
strategic choice (on what basis do we decide to compete? Which direction should we choose? How are we going
to achieve the chosen direction?)
strategic implementation (resource management, organisational structure, management of change.)
All that is necessary now is to use the framework in an applied way relevant to the question asked.
Sean Purcell BA ACMA is a leading freelance lecturer for Paper P3 and lectures on the ACCA Study School and Train
the Trainer Programme for Paper P3

BUSINESS FORECASTING AND STRATEGY

Quantitative data has always been supplied in the Paper P3 50-mark question and candidates are expected to
draw conclusions from it. For example, declining profitability might imply that a company is facing stiff
competition from powerful rivals and that it, therefore, has to decide on a strategy that could increase its
survival chances.
However, the strategic advice was often given without the benefit of proper forecasts other than an implicit
assumption that historical trends were going to continue: if market share had been decreasing for a number of
years it was assumed that it would continue to decrease unless action was taken.
Section A2e of the Paper P3 Study Guide specifically includes Evaluate methods of business forecasting used
when quantitatively assessing the likely outcome of different business strategies. Therefore, the use of
forecasting has become a much more explicit requirement. In addition to its use in strategic decisions,
forecasting could also affect certain other syllabus updates such as the requirement to build a business case
(where costs and benefits have to be estimated), investment appraisal, the budgetary process, pricing, and risk
and uncertainty, including decision trees.
An outline of the key forecasting techniques
The recent examiners article explaining the syllabus changes stated that the key techniques include linear
regression, the coefficient of determination, time series analysis and exponential smoothing. All but the last item
should have been studied in Paper F5. In the exam, interpretation and an awareness of limitations rather than
calculations will be required.
1 Linear regression
Least squares linear regression is a method of fitting a straight line to a set of points on a graph. Typical pairs of
graph axes could include:
total cost v volume produced
quantity sold v selling price
quantity sold v advertising spend.
The general formula for a straight line is y = ax +b. So, y could be total cost and x could be volume. a gives the
slope or gradient of the line (eg how much the cost increases for each additional unit), and b is the intersection
of the line on the y axis (the cost that would be incurred even if production were zero).

You must be aware of the following when using linear regression:

The technique guarantees to give the best straight line possible for any set of points. You could supply a set of
peoples ages and their telephone numbers and it would purport to a straight-line relationship between these. It

is, therefore, essential to investigate how good the relationship is before relying on it. See later when the
coefficients of correlation and determination are discussed.
The more points used, the more reliable the results. It is easy to draw a straight line through two points, but if
you can draw a straight line through 10 points you might be on to something.
A good association between two variables does not prove cause and effect. The association could be accidental
or could depend on a third variable. For example, if we saw a share price rise as a companys profits increase we
cannot, on that evidence alone, conclude that an increase in profits causes an increase in share price. For
example, both might increase together in periods of economic optimism.
Extrapolation is much less reliable than interpolation. Interpolation is filling the gaps within the area we have
investigated. So, if we know the cost when we make 10,000 units and the cost when we make 12,000 units, we
can probably make a reasonable estimate of the costs when we make 11,000 units. Extrapolation, on the other
hand, is where you use data to predict what will occur in areas outside the region you have investigated. We
have no experimental data for those areas and therefore run the risk that things might change there. For
example, if we have never had production of more than 12,000 units, how reliable will estimates of costs be
when output is 15,000 units? Overtime might have to be paid, machines might break down, more production
errors might be made.
Remove other known effects, such as inflation, before performing the analysis, or the results are likely to be
distorted.
2 The coefficients of correlation and determination
The coefficients of correlation (r) and determination (r 2 ) measure how good a fit the linear regression line is. If
r = 1, there is perfect positive correlation, meaning that all the points will fit on a straight line, and as one
variable increases so does the other. If r = -1, there is perfect negative correlation meaning that all the points will
fit on a straight line, and as one variable increases the other decreases. If r = 0 there is no correlation and the
two variables show no association (age and telephone numbers).
The coefficient of determination, r 2 , is similar but is, perhaps, easier to understand. If r 2 is 80% (or 0.8) this
implies that 80% of the changes in one variable can be explained by changes in the other. Note carefully: this
does not mean that 80% of the changes in one is caused by 80% of changes in the other. Even good correlation
does not prove cause and effect.
3 Time series analysis
A time series shows how an amount changes over time. For example, sales for each month, profits for a number
of years, market share over each quarter. Because strategic management inevitably implies trying to look into
the future, time series analysis is extremely important. Very often the starting point for predictions will be based
on historical patterns of growth or decline, or a recognition that, in the past, amounts seem to have varied
randomly.
Time series are often analysed by using moving averages, and the Paper P3 specimen paper contains an
excellent example of how this is likely to be examined: not by performing the calculations (no one in their right
mind would do this manually nowadays) but by interpreting the results. In the following table, column 3 shows
the readings (sales units) for each quarter for three years.

Time series analysis usually recognises four effects:

A trend. This is the underlying growth or decline in an amount. For example, sales of a product could show
increases year-on-year.
To find a trend first decide on a likely periodicity or seasonality. For example, 6 for the trading days of the week,
4 for seasons of the year. Then ensure that the average is centred on a season. Above it has been assumed
there are four seasons, so 4-part averages are first calculated : 1,250 = (2,000 + 900 + 1,000 + 1,100)/4. That
average is between seasons 2 and 3. To obtain a centred average, average with the next one: 1,144 = (1,250 +
1,038)/2. Here, the 8-point moving averages move up and down implying no strong trend.
Seasonal variations. These are variations which repeat fairly consistently within a period of no more than a year.
For example, although the trend could be increasing, sales in summer could always be higher than sales in
winter. Variations are identified by the differences between the actual results and the trend figures. Again, this
table has been designed to show no stable seasonable variations and all seasons show both positive and
negative effects.
Cyclical variations. These are variations which repeat over longer than a year. For example, economic boom and
depression.
Random variations. Unexpected changes in what might be expected. For example, a very cold winter could
provoke much larger than normal sales of certain products.
Time series analysis usually concentrates on the first two effects. Once again, if must be emphasised that even if
a strong trend has been identified there is no guarantee that this will continue in the future. For example, a
product life cycle curve might show a strong growth trend early in a products life, but then at some point,
growth will fall off, and probably even further in the future the trend will show decline. Any prediction, even if
based on a large amount of historical data and using recognised and sophisticated techniques, can still be prove
to be very different to the actual results that occur. Judgment has always to be applied when assessing how
much to believe the results.
Let us say that we want to predict the sales for Quarter 1 of Year 4. Remember, in this table, we have detected
no well-defined trend and no well-defined seasonal variations. There are three methods:
The random walk model: next periods prediction is based on the latest actual and would, therefore, be
predicted to be 800. However, because the data obviously moves up and down frequently this method might
place too much emphasis on the latest actual result.

The simple moving average method: next periods prediction is based on the latest moving average and would
therefore be predicted to be 1,021. This averages out the ups and downs in the data, but suffers from two
potential problems:
(i) The predicted value lags the actual results because so much historical data is included in the prediction. One
could easily argue that 1,021 looks much too high given recent actual results.
(ii) Every time a new moving average is calculated, the oldest component of the calculation is removed from the
calculation, and a new one taken in. It can be considered as unrealistic and erratic to drop a reading so abruptly.
Exponential smoothing. Whereas time series analysis was a topic in Paper F5, exponential smoothing was not,
but it can be regarded as a refinement of the moving average technique. Here, a weighted average of the last
actual result and the last predicted result is used as the next prediction. The weighting factors used are arbitrary,
and alter how much importance is given to the last actual result and how much to the last estimated result; this
varies how stable or volatile the predictions are. So, if we began the process from Year 3 Season 2 and used
weighting factors of 0.5 and 0.5, the prediction for Season 3 would be:
0.5 x 1,180 + 0.5 x 1,021 = 1,101
The prediction for Season 4 would be:
0.5 x 900 + 0.5 x 1,101 = 1,001
And for Year 4 season 1 would be:
0.5 x 800 + 0.5 x 1,001 = 901
In general, the new prediction will usually not lag behind latest results as much with simple moving averages,
and historical results are not abruptly dropped. Instead, their importance to the prediction gradually decreases.
Dealing with risk and uncertainty in predictions
In the discussions above it has been emphasised that past performance is no guarantee of future performance. It
would, therefore, be unconscionable to plough ahead with plans based on estimates that you know must be
unreliable without examining what might go wrong.
You need to know two technical terms:
Uncertainty occurs when you know that there might be alternative outcomes, but cannot attach a probability to
each of those occurring. There, decisions rely greatly on personal attitude to risk and, in particular, should
examine the bad or worst case scenarios as these can lead to trouble.
Risk is where we feel we can assign probabilities to the various outcomes. The normal method of attack is to
calculate the expected value of the outcome.
Expected values can be fine if a project is repeated many times because the expected value will equate to the
long-term average result. However, most strategic plans, and any projects making them up, are once-off. That
introduces two problems:
usually the expected value is not an expected outcome
the expected value gives no hint about the spread of results that might occur.

Here, both scenarios have the same expected values, but Scenario 1 has very little risk. With Scenario 2,
however, outcome 2 could be very serious indeed for the organisation.
Risk can be handled by:
Toleration: the risk is thought to be so small that it can be borne. For example, Scenario 1 above might be
tolerable.
Treat: do something to reduce the risk. Perhaps we could carry out a plan in phases and see how each stage
does rather than being committed to the whole plan from the start. Alternatively, escape routes might be
available.
Transfer: perhaps by means of insurance, by sub-contracting some of the tasks and by entering into a joint
venture.
Terminate: the risk is so great and so impervious to treatment or transfer that we choose to avoid the
opportunity altogether.
Sensitivity analysis can play an important role in deciding how risk should best be handled: assumptions are
varied and the outcomes monitored. Often sensitivity is measured by the percentage that an assumption can be
varied before a project breaks even, though there is no need always to measure to the break even point.
Two other additions to the syllabus can be looked at here. Learning objective F4e looks at project gateways and
within Section G there is a requirement to evaluate strategic and operational decisions, taking into account risk
and uncertainty using decision trees.
Look at the following example: a development project is budgeted to cost $150 million and it is estimated that
after two years income will be $200 million if the project is successful (probability 0.8), or only $30 million if the
project is unsuccessful (probability 0.2). On a decision tree, this can be represented as:

The expected monetary value at point B is: 0.8 x 200 + 0.2 x 30 = 166 (circles represent where expected values
have to be calculated)
The decision to be made at point A (decision points are represented by squares) is either to abandon the project

(zero financial effect) or to go for it with an expected profit of 166 150 = 16.
It looks as though the company should proceed with the project, but that decision depends on its forecasts and
those could be wrong. You will see that if the expenditure rose by just over 10%, or if the successful income fell
from 200 by 10% to about 180, or the probabilities changed to about 0.7/0.3, then the project would be
breaking even or worse.
Let us say that actual expenditure rose to 200 and that, although the project was successful, its income there fell
to 180 only. We would wish that we had not embarked on the venture as it has made a loss of 20 (= -200 + 180).
Now imagine that we could have the project in phases:

At the outset, A, our decision would be to go ahead if we were happy about the risks (expected monetary value
as before = 16)
Say that A is now one year later. We will have better knowledge about how the project is turning out (70 was
spent in year 1 instead of 50) and perhaps altered probabilities and estimates. The decision tree could be
displayed as:

Note that the 70 already spent is now a sunk cost and not relevant to any decision about continuation of the
project. We are now at A on the diagram. The second phase has an increased cost, income has fallen and
success is less likely, perhaps because we have now identified additional technical difficulties. As it stands the
expected value of continuing is:
-130 + 0.75 x 180 + 0.25 x 30 = 12.5
This implies that it is worth carrying on, but the reliability of the estimates and the sensitivities would need to be
looked at carefully.
However, say that after the first year, the project showed the following:

Now the expected value of continuing at A is:

-148 + 0.75 x 180 + 0.25 x 30 = -5.5
Now, we would be more likely to abandon the project in the light of the new information that has become
available.
As time passes and projects progress, estimates inevitably change. This example illustrates how our decisionmaking might be affected by those changes and emphasises how important it is continually to keep matters
under review and to build in as much flexibility as possible, such as break clauses in leases or options to extend
operations.
Summary
Paper P3 candidates will be required to Evaluate methods of business forecasting used when quantitatively
assessing the likely outcome of different business strategies. Emphasis will be on evaluating methods and
results.
Linear regression allows an objectively obtained straight line to be fitted to any set of points, but of itself says
nothing about how good or reliable the fit is, nor whether there is a cause/effect relationship.
The coefficients of regression and determination allow assessment of fit.
Time series analysis allows both trends and seasonal variations to be estimated. It can be criticised because
historical readings are abruptly dropped as the calculation progresses. The calculated trends can lag substantially
behind what the actual data is currently doing.
Exponential smoothing is an approach which weights the latest actual results and the latest predicted results to
give the next predicted result. Past data fades from the calculation and the time lags are usually not so great.
No prediction method, no matter how scientific gives guaranteed answers and sensitivity analyses can give some
information about the risks involved.
Decision trees allow a series of decisions and outcomes to be mapped out and investigated.
Where possible, because the future is always uncertain, organisations should always try to build flexibility into
their planning and investment. For example, break clauses in leases and options to extend or expand operations.
Ken Garrett is a freelance lecturer and author
OUTSOURCING
22
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Student Accountant hub page
Outsourcing is when any operation or process that could be or would usually be performed in-house by an
organisations employees is sub-contracted to another organisation for a substantial period. The outsourced
tasks can be performed on-site or off-site.

Outsourcing is currently relatively popular with both profit-seeking and not-for-profit organisations, and we will
see both its potential advantages and disadvantages later in this article.
It is important to appreciate that outsourcing will almost certainly continue to be examined as part of a scenario
in the Paper P3 exam, so you could be required to, for example, describe the specific advantages that
outsourcing could bring to the organisation described in the scenario.
Additionally, outsourcing lends itself very well to financial calculations, as seen in the June 2011 exam.
Essentially, a decision to outsource is likely to save some internal costs but incur additional external costs.
Revenue could also change if, for example, outsourcing increased capacity. Therefore, the decision to outsource
could be heavily influenced by marginal cost and marginal revenue considerations.
Before looking at a specific scenario, we will briefly explain the standard advantages and disadvantages of
outsourcing and describe some common outsourcing applications.
Common outsourcing applications
It allows the organisation to focus on its core, value-adding activities without the distraction of having to run
support services. Support services can soak up both management time and financial resources and these would
usually be better spent concentrating on where the business can use its resources and competences to gain
competitive advantages.
Cost savings. Usually the organisations to which activities are outsourced specialise in those activities and,
therefore, are likely to enjoy economies of scale, whether from the use of machinery or the employment of
expertise. There can be additional cost savings if a process is outsourced to a foreign company operating in a
cheaper labour area (off-shoring).
Cost certainty. An outsourcing contract at a fixed, or closely defined price, shifts much of the financial risk on to
the provider. Costs become more predictable.
Cost restructuring. For some types of outsourcing such as component manufacturing, there will be lower fixed
costs and higher variable costs. If all components are bought in, then these costs are all variable. Had the
components been made in-house, there would inevitably have been associated substantial fixed overheads.
Access to cutting edge expertise and talent. In technically advanced, fast moving industries, it can be difficult for
small companies to develop or make use of new processes. Outsourcing to a specialist company can give access
to the latest technologies.
Better quality. There can be an immediate improvement in quality if a process is outsourced to a world-class
company where the quality is carefully defined in a service level agreement.
Risk transference. If a company perceives that one of its processes has high risks, then this can be transferred by
outsourcing to another company.
Capacity management. For example, it can be difficult for businesses to deal with variable demand: either they
run out of capacity (unhappy customers), or have (expensive) unused capacity. Outsourcing to a large company
can mitigate this problem.
Potential disadvantages of outsourcing
Unexpected costs. Although many costs become more predictable, the supplier will be very careful to define
exactly what these costs cover. There are likely to be substantial additional charges for anything extra.
Additionally, remember that almost certainly the supplier knows that part of the business better then the
outsourcer and will ensure that the contract is carefully (and advantageously) worded.

Difficult to reverse. Once an activity is outsourced and internal knowhow gone, it can be very difficult to bring a
process in-house again. This is particularly relevant when a contract comes up for renewal: the price increase
might be higher than expected but it can be difficult t o abandon the supplier.
Damage to reputation. If the outsource company does not perform properly for example, not manufacturing
to the required quality standards and not supplying goods on time great damage can be d one to the
organisations reputation.
Non-congruent objectives and loss of managerial control. The supplier company makes money doing things
efficiently. The buying company might make money by innovation. To some extent, despite the contract, there
can therefore be a difference in the objectives and core values between the two parties.
Success depends on another companys performance. Though there is always a dependency between buyers
and sellers, outsourcing shifts more responsibility for success to other companies performance. If an important
outsource company goes bankrupt, there can be serious consequences.
Confidentiality/security. Outsourcing some processes can give the supplier information that could be valuable or
sensitive. Keeping a process in-house should increase security.

Examples of outsourcing
Catering facilities. For example, Compass Group UK and Ireland has a turnover of almost $3bn and its main
business is providing catering facilities for organisations such as schools, hospitals, client entertainment,
businesses, and sports and leisure venues.
Document handling. Document handling is a serious problem for many companies and there are often legal
requirements to preserve documents for many years. The company Ricoh offers scanning and archiving facilities
(both electronic and hard copy), printing (including folding and binding), mail room (receipt, sorting delivery and
dispatch). Increasingly, incoming documents are scanned and stored electronically. That way, documents are
instantly retrievable and can be used simultaneously by several people.
Technology services/IT. Because of the large investment, high specialist expertise needed and rapid
technological changes, this one of the most common processes to be outsourced.
Accounting services. For example, receivables ledger maintenance or wages and salaries administration.
HRM. Recruitment, legal considerations (for example, complying with equal opportunities legislation), appraisals,
contracts, disciplinary, grievance.
Fleet management. Purchase, maintenance and disposal of vehicles.
What should be outsourced?
Harmons Process Strategy Matrix provides very useful guidance about which processes can be safely outsourced
and which should be kept in-house, but subject to automation or other improvement.
It uses two axes:
Complexity/dynamism of the process. Dynamism is a measure of how much the process changes.
Strategic importance of the process

Notice that in the right-hand pair of quadrants, where strategic importance of the process is high, outsourcing is
not recommended. If a process is strategically important it is likely to be a source of competitive advantage. If
that were to be outsourced, then the company would be telling the supplier about its most valuable secrets and
competences. What would then be left for the outsourcer to do? If a process is relatively stable and noncomplex, then automation would be feasible and worthwhile. If, however, the process were very complex and
subject to many changes, then automation will be difficult to achieve and even more difficult to keep up to date.
Of the examples given in the previous section, with the exception of technology services, all are pretty firmly not
of strategic importance to most organisations. Technology services might or might not be of strategic
importance. If the organisation used IT for fairly routine accounting and management purposes, it is unlikely to
be strategically important. However, some organisations will use IT in a very creative way so that it becomes a
source of competitive advantage. Consider Amazon.com, the online supplier of books, DVD, electronic
equipment, etc. The company has very advanced customer relationship management software which, for
example, recommends books that you might like because of previous purchases you made, allows readers to
enter and read reviews, uses targeted emails to market special offers. IT is the mainspring of Amazon and it is
unlikely to ever outsource that foundation of its success.
Outsourcing and the commoditisation of business processes
When a process is going to be outsourced it is important that both parties know what is expected otherwise
there will probably be misunderstanding and trouble. However, often there is no clear mechanism for comparing
the capabilities and services provided by third party organisations and those that are provided in-house. If
processes are not standardised, then it will be difficult for companies to decide whether outsourcing will provide
value for money and to compare different potential suppliers.
There are three processing standards to consider:
Process activity and flow standards: exactly what are the processes, the information flows and the movement of
materials?
Process performance standards: once there is agreement about what a process consists of, this step establishes
the level of performance required. This can be built into outsourcing contracts.
Process management standards: how is the process monitored, documented, controlled and improved?
Once processes have been standardised this will lead to commoditisation of outsourcing, leading to more
competition and lower prices. Commoditisation means that buyers can largely buy on price (just as is often done
nowadays when buying a laptop computer) because the services provided will be essentially the same. Some
suppliers will no doubt try to escape this price competition by trying to differentiate what they do. For example,
in addition to providing the basic, commoditised outsourced process they might also begin to make suggestions
about how the process could be improved.

Example: June 2011 Question 1b

The EcoCar company was formed six years ago to commercially exploit the pioneering work of Professor Jacques
of Midshire University, a university in the country of Erewhon. Over a number of years he had patented
processes that allowed him to use lithium ion batteries to power an electric car, which could travel up to 160
kilometres before it needed recharging. Together with two colleagues from the university, he set up EcoCar to
put the car into commercial production. The company now manufactures three car models: the original Eco, the
EcoPlus, and the EcoLite.
Although EcoCar was established in an area where there already existed a pool of skilled car workers, the sub
sequent retirement of many of these workers has left a skills gap. Although unemployment remains high in the
area, applicants for jobs appear to lack the skills and motivation of the older workers. EcoCar is finding it difficult
to recruit skilled labour and this shortage is being reflected in increased wages and staff costs at the Lags Lane
site. The urban location of the Lags Lane site also causes a problem. Inbound logistics are made expensive by the
relative inaccessibility of the site and the general congestion on Midshires main roads.
Finally, there is insufficient production capacity at the Lags Lane site to meet the current demand for EcoCars
products. EcoCar attempts to produce the most profitable combination of its products within this constraint.
However, it is unable to completely satisfy market demand. To address the first internal weakness, Universal
Motors is considering outsourcing the manufacture of the EcoLite model to an overseas company. Information
relevant to this decision is presented in Figure 2. The potential manufacturer has quoted a production price to
Universal Motors of $3,500 per car. The manufacturing plant is approximately 300 miles from Erewhon, which
includes crossing the 40-mile wide Gulf of Berang.
There are 112 product ion hours available in total per week at the Lags Lane site (seven days per week, two eight
hour shifts) that can be used for a combination of the three product lines.
The weekly overhead costs are $35,000 per week at Lags Lane. If the production of the EcoLite model is
outsourced, it is forecast that overhead costs will fall by $1,250 per week. The transportation cost is estimated at
$250 for each outsourced EcoLite produced.

Selling price per car ($)

Variable cos t per car ($)
Weekly demand (cars)
Production time per car (hrs)

Eco
9,999
7,000
6
9

EcoPlus
12,999
10,000
5
10

EcoLite
6,999
4,500
6
8

Universal Motors is considering outsourcing the EcoLite model to an overseas manufacturer, while retaining inhouse production of the Eco and EcoPlus models.
Required:
Evaluate the financial and non-financial case for and against the outsourcing option. (15 marks)
The financial case
There is a key/restricted resource problem here because to produce the total weekly demand, 152 (= 6 x 9 + 5 x
10 + 6 x 8) hours of production time would be needed but only 112 hours are available. Before outsourcing any
production, Ecocar can maximise its profits by calculating the contribution per unit of key factor for each vehicle:

If the production of EcoLite is all subcontracted, then there is no capacity constraint because hours needed for
the Eco and EcoPlus will amount to 104 (54 + 50) and 112 are available. The surplus eight hours would allow one
EcoLite model to be produced in-house, but it is assumed that all production will have to be subcontracted to
achieve the lower fixed overheads.

Therefore, the financial case for outsourcing EcoLite production is very strong indeed, producing an
improvement in monthly profits of $17,746. The improvement is principally due to the very much lower cost per
unit of EcoLite ($4,500$3,500), somewhat offset by the increased transport cost per unit of $250.
It is hard to see any financial case for not outsourcing production of the EcoLite. Indeed, the cost benefit arising
from outsourcing the EcoLite is so marked that it implies EcoCar is an inefficient, high-cost manufacturer and
that production of all models could be advantageously outsourced and the effects of outsourcing the production
of the other models should be investigated. Presumably if all production were outsourced, then this would also
allow all production fixed costs ($35,000/week) to be saved. In effect, then, all production costs become
variable.
Non-financial considerations (note that every paragraph below mentions points specific to EcoCar)

Advantages include:
Allowing the company to focus on its core skills, which would appear to be the development of efficient battery
technology and not manufacturing. Manufacturing is not of strategic importance to EcoCar: its technology and
patents are. In terms of the Harmon grid, manufacturing is likely to be in the top left quadrant.
Capacity management. It is likely that the foreign manufacturer will have greater manufacturing capacity
(already restricted in EcoCar) that will allow the company to expand easily.
Cost certainty. There are labour, transport and motivational problems at the Lags Lane site, all of which add to
cost uncertainty. Sub-contracting using fixed price contracts will reduce this though care will be needed to deal
with currency fluctuations because the proposed sub-contractor is a foreign company.
Expertise, quality and capacity. EcoCar is a new, small, inexperienced manufacturing company. Success in
manufacturing often depends on large, skilled and efficient operations that could be better obtained by
outsourcing.
Potential disadvantages include:
Damage to reputation but there is no evidence here that the outsourcer would produce lower quality goods
than EcoCar. However, the outsourcer is 300 miles (about 500 km) away and across the Gulf of Berang. The
purchase of a car is not an event that is likely to be very dependent on instant supply, and certainly will not incur
idle labour costs, so 300 miles of itself is unlikely to be a problem. The Gulf of Berang is somewhat enigmatic and
it would be worthwhile investigating if there were, for example, political problems in the area that could
interfere with supplies.
Non-congruent objectives. However, here it is difficult to see how these could arise. The manufacture of physical
products such as EcoCars vehicles is easy to define and monitor.
Success depends on the other companys performance. As above, contractual arrangements and careful
monitoring of the quality of cars produced should reduce this risk.
Although EcoCar makes use of the patents of Professor Jaques, patents (by definition) are filed publically and t
he technology is open for all to see. No additional confidential information will be disclosed by outsourcing.
Ken Garrett is a freelance lecturer and writer
VALUE CHAINS, VALUE NETWORKS AND SUPPLY CHAIN MANAGEMENT
119
RELATED LINKS
Student Accountant hub page
This article considers writer Michael Porters value chain framework, which has been described as a powerful
analysis tool for companies in strategic planning to create value. It also highlights the various definitions of supply
chain management put forward by different writers
Sections A4, E2 and E3 of the Syllabus and Study Guide relate to value chains and value networks, and Sections
E2 and E3 of the Paper P3 Syllabus and Study Guiderelate to the supply chain with particular, but not exclusive,
reference to the application of e-business.
Value chains and supply chains have featured explicitly in the pilot paper, December 2007, December 2009 and
June 2012 exams. In addition, value chains can often be used in position analysis.

THE VALUE CHAIN AND VALUE NETWORKS

Porters value chain displays groupings of all the activities that organisations carry out. The activities are divided
into primary activities and secondary activities. All activities have costs and successful businesses organise and
carry out their activities in such a way that value is added. It is the value added that allows revenues to exceed
costs so that profits are made.

To add value, the organisation must be doing more for its customers than simply carrying out the face value of
the activities, otherwise customers would presumably carry out the activities themselves. Customers either
cannot carry out the activities at all, or cannot match costs, or dont want to carry on the activities and so are
willing to pay others to carry them out instead. For example:
knowhow suppliers often use knowhow that customers simply dont have
economies of scale suppliers often produce efficiently in huge volumes with each customer buying only a small
proportion. Suppliers economies of scale simply cannot be replicated by each customer
risk suppliers might shoulder production risks that customers dont want
location suppliers might be in a low-cost area while customers are in a high cost area
flexibility suppliers are variable costs, while doing it yourself usually entails more fixed costs.

As always, success in business arises from one of Porters generic strategies cost leadership or differentiation
each with or without focus. Value chains have to underpin the chosen generic strategy. So, if cost leadership is
the strategy, the value chain adds value by enabling low cost production.
Curiously, the value chain relegates procurement (the purchase of goods and non-current assets) to a support
activity, yet has sales and marketing in primary activities. In modern manufacturing companies this disparity
does not make a lot of sense because what is important is the complete chain from suppliers to customers. This
is acknowledged in the idea of value networks:

Value networks recognise that few companies stand alone and that what is ultimately supplied to and paid for by
customers depends on activities carried on by many suppliers, distributors and, indeed, logistical companies.
Ultimately, customer satisfaction and value added depend on all parties working well together.

THE SUPPLY CHAIN AND SUPPLY CHAIN MANAGEMENT

There is no generally accepted definition of the term supply chain management and many different definitions
can be found in relevant literature. For example:
A concept whose primary objective is to integrate and manage the sourcing, flow and control of materials using
a total systems perspective across multiple functions and multiple tiers of suppliers. La Londe and Masters
(1994)
The objective of managing the supply chain is to synchronise the requirements of the customer with the flow of
materials from suppliers in order to effect a balance between what are often seen as conflicting goals of high
customer service, low inventory management, and low unit cost. Stevens (1989)
an integrative philosophy to manage the flow of a distribution channel from supplier to the ultimate
user. Cooper et al (1997)
From these definitions, it can be seen that supply chain management has the following features:
Integrating and managing the sourcing, flow and control of materials.
Supply chain management covers the flow of materials suppliers through to customers
Potentially many suppliers and customers.
Synchronising of materials received, processed and despatched to customers.
Simultaneously achieving good levels of customer service and low costs for the company.

Supply chains are often divided into upstream and downstream operations in an analogy with material floating
down a river, into and then out of operations:
Upstream the flow of materials into the organisation.
Downstream the flow of materials from the organisation to the customers.
However, these terms might sometimes have to be interpreted liberally as materials can go directly from
supplier to customer with the organisation itself acting as a co-ordinator of the flow.
For businesses that manufacture their own products, the upstream supply chain will be taken to consist of the
following value chain activities:

Procurement purchasing inputs such as supplies, material and equipment.

Inbound logistics receiving raw materials, holding inventory and issuing to manufacturing operations as
required.

Downstream supply chain will be assumed to consist of:

outbound logistics the storing and distribution of finished goods.
marketing and sales identifying customer needs and generating sales.
services.

You will note that procurement and marketing and sales do not
themselves involve any movement of goods, but these activities initiate the flows of raw materials, components
and finished products, so need to be included as part of supply chain management. Service can also be included
here as certainly the supply of elements such as consumables, maintenance and training can be valuable sources
of value added and need to be managed.
A useful view of supply chain management is suggested by Meyr, Wagner and Rohde (2004):

Here, in contrast to Porter:

procurement is seen as a primary activity and will include inbound logistics, or their equivalent. Procurement is a
central part of the supply chain and not merely a support function. Wise and skilled purchasing, as well as the
physical movement of goods, will be capable of creating value
customer-facing activities (previously, sales, marketing and services) are combined into sales
production is used instead of operations in Porters value chain. This is more precise (but perhaps more
restricted).

The important additional emphasis in this presentation is on collaboration between up-stream suppliers and the
down-stream customers. Together, they form the value network that creates value through the appropriate
operation of the whole chain to improve efficiency, delivery accuracy and times, cost reduction and inventory
minimisation.
You will readily understand that collaboration can often be greatly facilitated by the use of information
technology, which can integrate online orders received from customers with manufacturing inventory
management and purchases of raw materials and components from suppliers.

PUSH/PULL SUPPLY CHAIN MODELS

A push model of the supply chain relies on manufacturers producing according to historical demand patterns
and pushing products out to distributors and customers. Inventory is held at various points as a buffer against

unexpected demand or production delays. By contrast, in a pull model demand stimulates production and
delivery. Essentially, just-in-time inventory control is a pull model as ordering and production are triggered by
customers orders. No orders are raised nor production started until there is downstream demand.
Of course, pure push or pull models exist only in theory: demand for a product will never cause a supply chain to
start mining iron ore and producing steel. Nor will a push model guarantee that products made will be bought.
At some point, in every supply chain, demand push will meet demand pull, and inventory will accumulate there.
Note that large geographical distances between suppliers and customers, or processes that take time (such as
growing crops) make pull systems more difficult to organise.
However, inventory can be minimised and customer service improved if all parties in the supply chain can be
better synchronised and have the ability to react quickly. For example, a traditional model of replenishing
inventory in supermarkets would rely on each supermarket issuing an order to suppliers, probably by electronic
data interchange (EDI), once inventory falls below reorder level. However, orders then arrive out-of-the-blue at
suppliers, who either have to have sufficient production capacity or who have to hold inventories to respond
quickly. A better way is to give suppliers access to supermarkets inventory records through an extranet so that
inventory levels and rates of change can be monitored. Supplies can be dispatched even without having to wait
for an order. In this way, suppliers will be much better able to anticipate demand and produce accordingly.
Better synchronisation and lower inventory levels have been achieved.
Information technology is of great assistance in moving towards a pull model as it influences the downstream
supply chain through the 6Is of e-business:
Intelligence for example, internet sites can track user activity and from that analyse which products are
growing or falling in popularity. Information can be fed directly into a data warehouse for subsequent analysis
and data mining.
Interactivity internet customers can customise their purchases. For example, some computer companies build
to order allowing different combinations of hardware and software to be chosen.
Integration following on from interactivity, once an order has been placed, the pull process can begin by
scheduling component ordering, production and despatch.
Individualisation for example, relevant offers can be made to each customer. If someone has bought a
particular printer, then subsequently offers can be made to sell ink or toner cartridges.
Independence (from location) the location of the supplier is largely irrelevant provided a good procurement
and distribution system is in place. This is covered further below under logistics.
Industry (structure) fast responses to customer demand is liable to affect industry structure as it will often
favour larger, better-organised companies who make use of sophisticated ordering and delivery solutions. There
are fewer and fewer places in which poor performers can hide.
SUPPLY CHAIN CHOICES
Supply chain pathways can be complex:

As with many other functions, outsourcing is increasingly used in supply chain management. Logistics companies
can perform many supply chain functions more efficiently and economically than they can be done in-house, and
we will see some examples below.
Some of the main choices to be made in supply chain pathways are as follows.
(1) Who transports the goods? The main solutions are:
the buyer transfers them using own transport
the seller transfers them using own transport
a logistics company transfers them
(2) What delivery pathways are best?
(3) Who stores the goods? The organisation, the supplier, or a logistics company.
(4) Which manufacturing, packaging, labelling, kitting, or completion tasks are carried out by the organisation
and which by other parties? (Kitting relates to processes such as adding batteries).
(5) Who is responsible for quality assurance and proper handling of the goods?
(6) How should returns be handled?
(7) How can fast and responsive deliveries by arranged?
(8) Who handles customs clearance?

SUPPLY CHAIN EXAMPLES

Pharmaceutical: Many pharmaceuticals, such as insulin and flu vaccines, are temperature-sensitive and have to
be stored below, say, 5C to maintain their efficacy and safety. Manufacturers therefore need ensure that their
worldwide distribution, by air and road, to hospitals and pharmacies can be guaranteed to have complied with
the storage required and that this can be verified and demonstrated. It is not realistic for pharmaceutical
companies to carry out such specialised distribution themselves on a worldwide basis, as this would imply
refrigerated warehouses, air freight and transportation in every country supplied. Many logistics companies offer
suitable services.
Packaging: Transporting packaging is wasteful, adding both weight and volume to products. Therefore, an
efficient distribution solution can be to export the basic products and then package those locally with using
language-specific packaging. Once again, it can be inefficient for manufacturers to do this and frequently
logistics companies carry out locally the packaging, printing instructions and labelling.
Customs clearance: Each country tends to have its own import regulations and tariffs. Navigating through these
requires considerable local expertise and logistics companies are often used to facilitate the efficient
international movement of goods.
Distribution: Imagine you distribute a product throughout Europe and customers need stock replenished
frequently and quickly. One solution would be to set up your own warehouses and distribution vehicles in every
country. However, you will realise that this would require vast resources. Almost certainly it would be better to
outsource this to a logistics company as that is likely to enjoy great economies of scale. The logistics company
can both warehouse the goods locally and provide transport to customers allowing a more just-in-time approach
to be taken.
Ken Garrett is a freelance lecturer and author